Valuation is one of the cornerstones of surveying. There are five methods that valuers should be familiar with, all of which use comparable evidence to some degree.
The comparative method is the simplest approach to valuation and, as its name implies, it works on the principle that the value of one property may be derived by comparing it with prices achieved from transactions of similar properties. This method of valuation is used for straightforward residential, rural and commercial properties. The process of identifying, analysing and applying comparable evidence to a property to be valued is fundamental to producing a sound valuation. Valuers’ opinions will have to withstand scrutiny from a client, the market and even the courts, in the case of being an expert witness or in the course of a claim.
Evidence
A “comparable” can be described as “an item used during the valuation process as evidence in support of the valuation of a different item of the same general type”. Comparable evidence comprises a set of these comparables used to support a valuation. Whatever the property being valued, the valuation will rely on the principle of substitution. This is that “a buyer of an item would not pay more for it than the cost of acquiring a satisfactory substitute”.
Comparable evidence is only as good as the information provided. It should always be:
Comprehensive: a number of comparables should be obtained. Some lenders require at least three, rather than just a single transaction, which may have been a one off.
Similar: are the comparables similar to the item being bought or valued?
Recent: are the comparables current? If not, what has happened to the market since? For example, the sale of the house next door to the one being valued five years ago could prove to be good evidence if it is known that the local market has gone up or down by 10%. This is where conversations with agents are invaluable.
Arm’s length: were they open-market transactions or the result of a specialist purchaser? What is the background to the sale?
Verifiable: can they be confirmed? Valuers should always check the evidence. Is it robust and accurate?
The complex nature of most properties is another factor that affects the use of comparable evidence. A property’s value is the reflection of the collective impact of numerous factors. The more of these elements that are in common between the property being valued and the comparables gathered, the better.
Location: this is probably the most important factor. It can be on a macro level: for example, postcode-by-postcode or village-by-village; or a micro level: for example, street-by-street.
Age and condition: this will have a clear effect on value. In other words, what would be the cost of transforming the property being valued from poor or derelict condition to the market standard? This would normally be expressed in terms of pounds per square foot, or in the case of a more complex project, a full residual appraisal could be applied. Age can be consistent with architectural style: for example, how many people would prefer a Georgian house to one built, say, in the 1960s?
Tenure: this would be in terms of freehold or leasehold. If leasehold, what is the unexpired term? Does the property qualify for a lease extension or enfranchisement? What is the difference in value between a 35-year lease and, say, a 28-year lease? Or perhaps an 85-year lease and a 75-year lease? Watch out for the marriage value trap below 80 years.
Ground rent should not be forgotten either. Are there any reviews? It is not uncommon to find properties where the ground rent reviews are calculated by way of the freehold value of the property. Ground rents can increase from £1,000 per annum to tens of thousands of pounds. This needs to be differentiated from a property where the ground rent was fixed at £100 per annum for the term.
Or perhaps the property is let? What are the terms of the tenancy agreement? What would the difference in value be between a property that has just been let on a three-year term with no landlord break to one where the tenancy is about to come to an end? Even if a property is freehold there may be restrictions on use either imposed through the title (restrictive covenants) or by the local authority.
Size: comparable properties should be of a similar size or, if not, adjusted accordingly for quantum. In the residential sector, properties of different sizes will appeal to different market sectors. Would a buyer expect to pay the same rate per square foot for a studio flat as a five-bedroom flat?
Date: The transaction date is important as markets are fluid and subject to price fluctuations, often sudden and unpredictable.
Information derived from relevant comparable market transactions will normally provide the best evidence of value. Of course, the quality of evidence is likely to be determined by its source.
Direct evidence is the best and most reliable source. It is important that a valuer has experience with the type of property being valued and its location.
Speaking to local agents is invaluable. What is the market like? What is the demand? What are the type of buyers? There is no substitute for seeking the opinion of those who are dealing with sales on a day-to-day basis.
Evidence from publicly available information such as the Land Registry may offer details of tenure, contract sum, date and title. However, it does not include other relevant aspects, such as condition, arrangement and floor area – vital when trying to compare one property with another.
Asking prices themselves do not provide reliable evidence of value and should be treated with caution. They may be “client led” reflecting expectation rather than reality and will usually vary from the price achieved on exchange in the open market.
Historic evidence can be helpful if combined with market trends and indices. A valuer specialising in a particular area may be asked to value the same property more than once and this previous knowledge is invaluable. What has the market done since the valuer’s last valuation? Has the property been improved or extended? Has the lease been extended or the freehold acquired?
Indices are a useful tool. They are normally derived from aggregated information about market values or transactions. For commercial investment property, the best known is the Investment Property Databank. For residential property, the RICS, Nationwide and Halifax all produce indices.
The evidence used to arrive at an opinion of value should be recorded carefully. It is good practice to ensure documents such as sales particulars, correspondence and records are kept.
Analysis
Having gathered all this information, it will be useless without taking the final step: analysis. The process of analysis converts the raw data accumulated into supporting evidence.
The first step is establishing a common measuring standard so as to compare like with like. The RICS Code of Measuring Practice indicates different units of measurement depending on the type of property being valued.
It is rare to find two identical comparables, so adjustments should be made to allow for differences in the various factors that may affect value. These may include location, specification, tenure and so on.
Other adjustments may be harder to define and will come from knowledge of the type of property and location. Such variables may be judged as having a positive or negative affect on value. But to what degree? 5%? 10%? What is the difference between a south- and north-facing garden, for instance? What about the difference between a first-floor flat and a fifth-floor flat? Or those same flats in buildings with or without lifts?
Analysis should be kept to a minimum. The more adjustments that are needed, which after all are subjective, the less comparable that property will be to the property being valued.
It is not uncommon for there to be a shortage of evidence available: an inactive market could mean few transactions. Or, conversely, in a fast-moving market, transactions can quickly become out-of-date.
For these reasons, comparable evidence will never be a perfect match for the property subject to valuation and there will always be a range of values suggested. It is often said that “valuation is an art, not a science” and thus it is the skill of the valuer to analyse and interpret the data and use it to provide guidance for the valuation figure to be reported. In weak or rapidly moving markets, or for certain types of property, good evidence may be limited and, despite a valuer’s skills and experience, a note of caution when reporting a figure may be required.
Why this matters
Comparable evidence is at the heart of virtually all real estate valuations. All five methods use comparison to some degree.
Comparable evidence will never be a perfect match for the property subject to valuation and there will always be a range of values suggested. It is the skill of the valuer to analyse and interpret the data and use it to provide guidance for the valuation figure to be reported. It is important to start with the correct method of valuation.
In contrast to the market for publicly quoted company shares, which have an exact price at a given date, the number of transactions for any category of property may be limited. The volume of comparable evidence may be reduced further because no two properties are identical.
Two houses on a new estate or two units in a block of flats may, at first sight, appear to be similar, but there will probably be differences in aspect, condition and arrangement. It is these differences that can have an impact on value and it is the skill of the valuer to determine what differences are relevant and which are not.
The process of identifying, analysing and applying comparable evidence to a property to be valued is fundamental to producing a sound valuation. A valuer’s opinions will have to withstand scrutiny from the client, the market and even the courts.
Treat indices with caution. They can be a useful guide to general trends in the market against which the performance of the property being valued can be judged. However, they cannot assist in markets that are inactive or where transactions are scarce. In addition, they can be generic and may not be suitable for every type of property valued.
Analysis of comparable evidence cannot be taught because there is seldom a right or a wrong answer. Each valuation will be different: for different clients, and for different purposes.
Sebastian Deckker is a director in Savills’ valuation department
